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Wednesday, April 6, 2011

The latest Asian Development Outlook 2011 has a 4-pager update (authored by Yubraj Acharya, ADB Nepal Resident Mission) on the Nepali economy. It states that political uncertainties, unfavorable weather, and weakening remittances from abroad impacted economic growth in last fiscal year. It projects growth rate to fall below 4 percent in FY2010/11, reflecting the “protracted post-conflict transition process”.

The ADB estimates Nepal’s GDP growth rate to be 3.8% in FY2010/11 and 4.0% in FY2011/12 (assuming favorable monsoon and weather). Inflation is estimated to be 10% and 8% in FY2010/2011 and FY2011/12, respectively. Current account balance (share of GDP) is expected to be negative 0.5%. The GDP growth projections of the World Bank and the ADB are pretty much similar. Earlier, the WB projected that Nepal’s real GDP growth to be 3.7% and 4% in 2011 and 2012, respectively.

The ADB is hopeful that tourism and more vibrant construction activity will modestly boost growth in FY 2011/12. Meanwhile, agricultural sector is expected to grow by 4% in FY2010/11, up from 1.3% in FY2009/10. This is expected to have some push on GDP growth rate as the performance of the agricultural sector has a heavy weight on growth in Nepal. But, delay in completion of the transition, high food and oil prices, and the impact of the unrest in the Middle East (primarily hitting remittances inflows) are the major risks to the economy.

The higher growth rate in FY 2009/10 (4%) than that in FY 2008/09 (3.8%) is attributed to increased economic activity in small industrial sector (thanks to fewer political strikes) and the expansion of services sector. Deceleration in the growth rate of remittances and excessive lending to real estate led to liquidity crunch in the banking sector.

The ADB notes that high food-inflation in India and low domestic crop production was the main source of high inflation in the economy. These are two of the causes. The report misses to mention the role of high global food and fuel prices starting 2008 as the main source of inflation that has remained sticky ever since. The other factors that are having a drag on domestic prices are supply bottlenecks due to extended periods of bandas and strikes, leading to shortage of essential items. Additionally, hoarding, black marketeering, deliberate withholding of supplies and inventory, and agricultural trade hurdles imposed by our neighbors contributed to keeping prices higher even after the normalization of market forces in the domestic economy. Here is an article that details why there is such a high level of sticky prices in Nepal.

Anyway, the report notes that exports are decreasing due to low productivity and infrastructure bottlenecks, leading to eroding competitiveness. It should also be noted that protracted energy crunch, labor militancy, and supply side constraints are also weighing heavily on the loss of exports. Imports surged more last fiscal year because of high gold imports, which has become a hot investment commodity after the squeeze in real estate market. The widening trade deficit and decelerating growth rate of remittances pushed current account deficit to 2.7% of GDP last fiscal year from a surplus of 4.2% of GDP the year before. The official reserves declined by US$113 million and Nepal drew US$42 million from IMF’s Rapid Credit Facility to offset external shock.

The ADB expects that further monetary tightening will not happen as real estate activity is already slowing down and the expected moderation of price levels in India will put less pressure on prices in Nepal.

Nothing major new or enlightening stuff to guide policymaking is in the brief report. But, it is a good rundown of the state of major macroeconomic variables and how the events of last year impacted them.

Asia and the Pacific is poised to grow at 7.8% in 2011 and 7.7% in 2012, according to Asian Development Outlook 2011.The projected growth rates are lower than the 9% posted in 2010, but the ADB projects that the region will continue its firm recovery from the global economic crisis.

But, inflation remains a major worry. It argues that inflation will need to be carefully managed using a mix of policy measures, including more flexible exchange rate management and coordinated capital controls, rather than simply relying on tighter monetary policy. After expanding at 4.4% in 2010, consumer prices are set to accelerate further to 5.3% in 2011 before easing back slightly to 4.6% in 2012.

South Asia will maintain its recent robust economic performance with forecast growth of 7.5% in 2011 and 8.1% in 2012, following a 7.9% expansion in 2010. India's 2010 performance was particularly strong and broad-based, even with fiscal consolidation and monetary tightening, and the economy is set to strengthen further to post 8.2% growth in 2011 and 8.8% in 2012. Pakistan's devastating floods weighed on its growth performance, while the end of the conflict in Sri Lanka continued to help underpin its economic expansion. In January, the World Bank projected South Asia’s real GDP growth accelerated to an estimated 8.7 percent in FY2010-11 from 7.0 percent in FY2009-10, buoyed by very strong growth in India, which represents 80 percent of regional GDP. It projected South Asia to grow by 7.7% and 8.1% in 2011 and 2012, respectively.

Should food and oil prices rise 30% in 2011 and not fall too sharply in 2012, economies of developing Asia (China, Hong Kong, India, Indonesia, South Korea, Malaysia, Philippines, Singapore, Taiwan, Thailand) would together see a 0.7 percentage point hit to growth.

The same scenario of 30% increases in 2011 would add 1.7 percentage points to inflation. The projected impact would be highest in India and Singapore in 2011, where inflation would rise by more than 2 percentage points each. Oil, rather than food, would have a bigger impact on inflation.

ADB calculates that for every 10% increase in local food prices, the percent of poor people in Asia, calculated as living on less than $1.25 a day, goes up 2 percentage points, to 29% of the population. That’s an additional 64 million people living in poverty because of higher food prices.

Should local food prices go up 30%, that would increase Asia’s poor to nearly a third of the overall population, or 1 billion people.

South-South cooperation: Strengthening economic links between countries in the South can create new global growth that can take up the slack left by cooling demand from industrialized countries in the North, according to a special chapter on “South-South Links”. Much of the growth in South-South trade has been driven by "Factory Asia", where intermediate goods sourced from the region are assembled in the People's Republic of China and other local manufacturing hubs before being exported to final destinations in the United States and Europe. South-South trade between Latin America, Africa and the Middle East has grown rapidly but still remains comparatively small.

India’s growth: India's economy will remain robust over the next two years although growth is expected to moderate in FY2011 as slower external demand and tighter fiscal and monetary policies weigh on expansion, and as high oil prices remain a threat. Improved agricultural output, strong private consumption, robust investment, and a pickup in exports supported growth in FY2010. Gross domestic product in the year to March 2012 (FY2011) will expand by 8.2% down from an estimated rate of 8.6% for FY2010. For FY2012, growth is expected to bounce back to 8.8% as investment and overall economic activity pick up and as planned reforms move forward. At the same time, continued inflationary pressure, a pullback in private investment and structural obstacles present challenges going forward. Fiscal and monetary policies will also remain less accommodating than in the past as the government follows its fiscal consolidation road map and the Reserve Bank of India acts to anchor inflation expectations. The government needs to tackle structural constraints including the poor agriculture supply chain and farm productivity. A positive start has been made with programs to remove production and distribution bottlenecks for farm products and these steps should continue, the report says. Transforming manufacturing by reducing infrastructure bottlenecks and investment hurdles linked to labor regulations, land acquisition and environmental clearances should also be addressed.

China’s growth: Slowing investment and exports will see growth in the People's Republic of China (PRC) moderate in 2011 and 2012.the economy is likely to expand by 9.6% this year and 9.2% in 2012. It grew by 10.3% in 2010, on the back of a strong recovery in exports and a rebound in investment and consumption. Fixed asset investment will remain a key driver of growth over the next two years, the report says, although the rate of expansion is set to decelerate slightly from past levels due to the winding back of fiscal stimulus measures and tighter monetary policy. However, a moderation in export and industrial output growth will offset this somewhat as demand from major markets remains sluggish and as tax rebates on some export products expire. The inflation rate, which averaged 3.3% in 2010, will pick up to 4.6% in 2011, lifted by abundant liquidity and higher food and commodities prices, before easing back to 4.2% in 2012 as commodity prices level off. The report notes that the PRC's rapid shift from a low to middle income economy over the past three decades has been accompanied by widening income gaps, widespread environmental damage and underdeveloped services. To support inclusive and sustainable growth, the Government will need to undertake broad policy adjustments such as increased public service spending, more financial sector liberalization, develop capital markets to help small enterprises and the self-employed access credit, and increase the role of the private sector.

About

Formerly, economics officer at Asian Development Bank, Nepal Resident Mission. Worked as a researcher at SAWTEE, Kathmandu. Also, worked as a consultant for Ministry of Commerce & Supplies, Government of Nepal; FAO; UNDP, GIZ-CIM, and ADB among others. I was an op-ed columnist for Republica between December 2008 – June 2012. I also worked as a Junior Fellow for Trade, Equity & Development program at Carnegie Endowment for International Peace, Washington, D.C .